How did software group pull off India's biggest corporate fraud?

How did software group pull off India's biggest corporate fraud?

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INDIA vowed to strengthen laws to prevent corporate fraud after Satyam Computer Sevices shocked investors by revealing profits had been falsely inflated for years.

What is within? A security guard standing outside the headquarters of Satyam in Hyderabad yesterday

Chairman Ramalinga Raju resigned on Wednesday after revealing India's biggest corporate scandal in memory, sending the company's shares plunging nearly 80 per cent.

The following is an overview of how the fraud escaped detection for so long and what compelled a soft- spoken man born into a family of farmers to risk all.

Q: How did Satyam escape detection?

A: On the face of it, New York-listed Satyam did everything by the rulebook, with an international firm auditing its books, declaration of accounts in accordance with Indian and US standards, and the requisite number of independent directors with excellent credentials, including a Harvard business school professor and a former federal cabinet secretary.

Mr Raju, in his now famous five-page letter outlining the deception, said no other board member - past or present - was aware of the financial irregularities.

Regulators were blindsided, and analysts and experts say there are 'systemic flaws' in accounting and audit practices.

About US$1 billion, or 94 per cent of the cash, on the company's books was fictitious, Mr Raju said, and manipulation of the cash flow may be a reason why the fraud was undetected.

'Companies have manipulated P&L (profit and loss) accounts before, but cash flow is the Holy Grail - you don't tamper with it,' said Saurabh Mukherjea, an analyst at UK-based research firm Noble Group.

'Auditors generally assume if there is cash, things are OK. But there are plenty of accounting and governance loopholes.'

India also lacks a culture of dissent, with shareholders and independent directors reluctant to question company founders.

Q: What was the motive?

A: India's US$50-billion information technology industry - the poster child for India's economic liberalisation and rapid growth - expanded at a scorching pace on the back of outsourcing demand from Western firms.

At the height of the boom, top software firms Tata Consultancy Services, Infosys Technologies, Wipro and Satyam consistently reported annual 50 per cent increases in profits every quarter.

Pressure to maintain this pace of growth, please investors and shareholders and justify inflated P/E multiples during a six-year bull run on the stock market have all been cited as reasons why Satyam cooked the books.

Some news reports say Mr Raju was an aggressive investor in failed dotcoms, and the family also put money in real estate.

Mr Raju, in his letter, said he had 'not benefited in financial terms' as a result of the inflated accounts.

Q: Are there other Satyams out there?

A: Most certainly, say analysts and industry experts.

While there has been a plea from chief executives across the board against painting all of corporate India with the same brush, Noble Group estimates at least a fifth of the top 500 listed companies practice 'creative accounting'.

'At its most innocent it is not illegal, but account manipulation is very pervasive,' said Mr Mukherjea.

Q: What needs to be done to prevent another Satyam?

A: Tighter rules for accounting and corporate governance, including appointment of independent directors by selection committees, and greater oversight from regulatory and government authorities.

Noble Group also suggests separation of audit and consultancy functions at companies, and quicker publication of annual reports. -- Reuters

 

 

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Quantitative Easing 101 - or the art of creating money

Quantitative Easing 101 - or the art of creating money

By EDWARD HADAS AND HUGO DIXON

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DESPERATELY ill patients are willing to try drugs that have not been shown to be either effective or safe. Even dodgy medicines look better than the alternative. As countries' financial systems remain immobile in the face of standard monetary policy treatment, more are turning to 'quantitative easing' as a therapy of last resort. The US Federal Reserve is already trying it out. The Bank of England is likely to follow. The European Central Bank probably won't because it doesn't seem to have the authority to.

Averting future disaster: Central banks and finance ministers must commit to reversing quantitative easing when the good times return - before they go wild and open the spigots

Quantitative easing is the modern way to print money. The central bank doesn't actually have to use a four-colour press to spew out crisp notes. There are more sophisticated ways to boost a nation's money supply. But ultimately the impact is not very different from dropping dollar bills from a helicopter as Ben Bernanke once described this policy before he became the Federal Reserve's chairman.

So what exactly is quantitative easing, what disease is it supposed to cure, how is it supposed to work and what are the possible side effects?

The theory

Quantitative easing is a method of boosting the money supply. Its aim is to get money flowing around an economy when the normal process of cutting interest rates isn't working - most obviously when interest rates are so low that it's impossible to cut them further.

In such a situation, it may still be possible to increase the 'quantity' of money. The way to do this is for the central bank to buy assets in exchange for money. In theory, any assets can be bought from anybody. In practice, the focus of quantitative easing is on buying securities (like government debt, mortgage-backed securities or even equities) from banks.

Where, one might ask, does the central bank get the money to buy all these securities? The answer is that it just waves a magic wand and creates it. It doesn't even need to turn on the printing presses. It simply increases the size of banks' accounts at the central bank. These accounts held by ordinary banks at the central bank go by the name of 'reserves'. All banks have to hold some reserves at the central bank. But when there is quantitative easing, they build up 'excess reserves'.

If banks swap their securities for reserves, the size of their own balance sheets shrinks just as the central bank's balance sheet expands. Assuming they want to keep their own balance sheets static - admittedly a big assumption in the current climate - they will then start lending to end-borrowers and so start putting more liquidity into the economy.

To some extent, central banks have been engaging in quantitative easing for the past year. The Fed, for example, has had a range of programmes and ad hoc initiatives that have resulted in it acquiring securities from the banking system and more recently from the US government. The Fed may not have justified these under the rubric of quantitative easing. But its balance sheet has certainly mushroomed: it is up 18-fold in the past four months to US$820 billion.

Does it work?

Such quantitative easing certainly hasn't yet done the trick so far in this recession. Credit conditions have continued to tighten in the US. Things, of course, could have been even worse if there hadn't been any easing. Equally, although an 18-fold increase in the reserves on the Fed's balance sheet sounds impressive, it is still below 6 per cent of GDP. It may therefore only be once quantitative easing properly gets going that the benefits will flow through.

Similarly, history isn't much use in judging the therapy's effectiveness. There has been only one significant trial - in Japan between 2001 and 2006. Excess reserves held by banks at the Bank of Japan rose from 5 trillion yen to 35 trillion yen (S$552 billion), roughly 6 per cent of GDP.

Scholars cannot agree whether the technique worked. On the positive side, Japanese GDP didn't shrink. On the negative side, GDP growth was moderate and not sustained after quantitative easing ended. Also, the experiment coincided with a big programme of government spending, so no one can tell whether it was the unusual monetary policy or the intense fiscal policy that kept the wolf from the door.

Almost no one would argue that Japanese quantitative easing was an unqualified success. But some economists think the Japanese were too slow and too half-hearted in applying the therapy. What's more, the Japanese record isn't necessarily all that meaningful for the US and the UK. Quantitative easing may work better - or worse - in a country like Japan with a cultural preference for savings and a huge trade surplus than in lands where borrow-and-spend has been the rule for years.

Unintended side effects

Even if quantitative easing isn't necessarily effective, it would certainly be worth a try if it carried no danger. But its safety is far from certain. It could theoretically lead to the debauchment of a nation's currency and inflation.

Again history doesn't provide much of a guide. Japan hasn't suffered any bad side effects - inflation is low and the yen is strong. However, in some more extreme examples of old-fashioned money printing, the results were disastrous. Witness the assignats of the French Revolution, Confederate dollars in the Civil War, Reichsmarks in Germany after World War I, Russian roubles after the fall of communism and the current hyper-inflation in Zimbabwe.

The US and UK are, of course, in a far healthier state than revolutionary France or the Weimar Republic. So there isn't a danger of such alarming consequences. But central banks might lack the will to engage in 'quantitative tightening' when the economy starts to pick up.

In theory, reversing the policy should be quite easy. The central bank could just sell the excess assets on its balance sheet, sucking money out of the system. In practice, the political pressure to keep the party going might be too hard to resist.

This is particularly so because, in order to engage in quantitative easing in the first place, some central banks may well need the permission of their governments. The more they work in cahoots with politicians, the more their independence will come under threat. Already, Alastair Darling, the UK Chancellor of the Exchequer, has made it clear that the government - not the Bank of England - will play an active role if quantitative easing proves necessary.

It is therefore essential that both central banks and finance ministers commit themselves to reverse quantitative easing when the good times return - before they go wild and open the spigots. Quantitative easing is risky. It needs to be practised safely.

 

 

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Moment of truth in fighting off depression

Moment of truth in fighting off depression Unless Congress gets its act together, Obama's stimulus plan will be delayed or downsized By PAUL KRUGMAN Email this article Print article Feedback 'IF WE don't act swiftly and boldly,'declared President-elect Barack Obama in his latest weekly address last Saturday, 'we could see a much deeper economic downturn that could lead to double-digit unemployment.' If you ask me, he was understating the case. The writing's on the wall: The biggest problem facing President-elect Barack Obama's economic stimulus plan is likely to be the demand of many US politicians for proof that the benefits of the proposed public spending justify its costs - a burden of proof that was never imposed on proposals for the Bush tax cuts The fact is that recent economic numbers have been terrifying, not just in the United States but around the world. Manufacturing, in particular, is plunging everywhere. Banks aren't lending; businesses and consumers aren't spending. Let's not mince words: this looks an awful lot like the beginning of a second Great Depression. So will we 'act swiftly and boldly' enough to stop that from happening? We'll soon find out. We weren't supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas of the University of Chicago, in his presidential address to the American Economic Association, declared that the 'central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades'. Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply. Ben Bernanke, the Federal Reserve chairman, famously apologised to Mr Friedman on his institution's behalf: 'You're right. We did it. We're very sorry. But thanks to you, we won't do it again.' It turns out, however, that preventing depressions isn't that easy, after all. Under Mr Bernanke's leadership, the Fed has been supplying liquidity like an engine crew trying to put out a five-alarm fire, and the money supply has been rising rapidly. Yet credit remains scarce, and the economy is still in free fall. Mr Friedman's claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy - large-scale deficit spending by the government - is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr Obama's plans to rescue the economy. But these plans may turn out to be a hard sell. News reports say that Democrats hope to pass an economic plan with broad bipartisan support. Good luck with that. In reality, the political posturing has already started, with Republican leaders setting up roadblocks to stimulus legislation while posing as the champions of careful congressional deliberation - which is pretty rich, considering their party's behaviour over the past eight years. More broadly, after decades of declaring that government is the problem, not the solution (not to mention reviling both Keynesian economics and the New Deal), most Republicans aren't going to accept the need for a big-spending, FDR-type solution to the economic crisis. The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs - a burden of proof never imposed on proposals for tax cuts. This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment 'which, because they are not wholly wasteful, tend to be judged on strict 'business' principles'. What gets lost in such discussions is the key argument for economic stimulus - namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful. All of this leaves me concerned about the prospects for the Obama plan. I'm sure that Congress will pass a stimulus plan, but I worry that the plan may be delayed and/or downsized. And Mr Obama is right: we really do need swift, bold action. Here's my nightmare scenario: it takes Congress months to pass a stimulus plan, and the legislation that actually emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally starts to kick in, it's only enough to slow the descent, not stop it. Meanwhile, deflation is setting in, while businesses and consumers start to base their spending plans on the expectation of a permanently depressed economy - well, you can see where this is going. So this is our moment of truth. Will we in fact do what's necessary to prevent Great Depression II? - NYT The writer is a professor of economics and international affairs at Princeton University and last year's winner of the Nobel Prize in Economics

 

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